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Michael Hasenstab

1995: Graduated from Carleton  College, Minnesota, with a  degree in international rela tions and political economy.

1995: Joined Franklin Templeton  Investments as an emerging  markets bond analyst.

1998: Began PhD study at Austra lia National University.

2001: Returned to Franklin  Templeton as portfolio man ager and analyst, interna tional fixed income.

MICHAEL HASENSTAB'S task as sovereign bond fund manager and analyst with Franklin Templeton is to weigh up the performance of governments.

With his Argentine colleague, Alex Calvo, who heads the firm's International Fixed Income group, Mr Hasenstab manages Templeton's Global Bond Fund and Emerging Markets Bond Fund.

Based in San Mateo, California, the two also share responsibility for currency and developed market macro analysis.

The job requires frequent travel to the sites of major portfolio holdings such as Russia and Latin America. After crunching their numbers and forming a preliminary view, the managers seek face-to-face meetings with officials. They try to get a feel of how well the nations' finances are managed.

'We enjoy good access to senior people like ministers of finance and central bank governors,' Mr Hasenstab said. 'That is important. That has been a big change in the past five years or so. The receptiveness of many governments to work with international investors has greatly improved. We are long-term investors, so I think there is a willingness on the part of governments to work with us and provide information.

'As they provide better information, price transparency increases as investors know they are getting good data. So they pay less on their debt when they come to market. They realise it is in their interests.'

Returns to bond fund investors come by way of a combination of interest payments, or coupon and capital gains on bonds held. The market value of sovereign bonds fluctuates according to perceptions of the nations themselves. Countries seen as risky credits need to offer higher interest on their bonds, which is expressed as a margin over United States Treasury rates.

Franklin Templeton and other bond fund managers try to identify countries where the market has got this equation wrong: the country might be risky, but the risk is not as high as the premium on the bonds suggests.

Within the emerging markets sector, recent experience shows bonds can offer better returns than equities during periods of equity market distress. Mr Hasenstab said this confounded the theory that emerging market bond returns were closely correlated to stock markets, and was an argument in favour of using them for fund diversification.

From 1992 to mid-2002, the mean return in the JP Morgan Emerging Market Bond index was 13.6 per cent, with a return volatility of 20 per cent. During the same period, Emerging Market equities returned just 7.2 per cent with volatility of 17 per cent. Mr Hasenstab said the high coupon payments on emerging market bonds were responsible for much of their high performance, offsetting price volatility.

The Templeton Emerging Markets Bond Fund's performance had reflected its benchmark over one, two and three years to December 31, 2002. The fund returned 9.7 per cent, 20.7 per cent and 29.8 per cent respectively against the JP Morgan Emerging Markets Global index's returns of 13.1 per cent, 14.6 per cent and 31.2 per cent.

Another fund managed by Mr Hasenstab and Mr Calvo, the Templeton Global Bond Fund, had clearly outperformed the benchmark, returning 24.2 per cent, 22.6 per cent and 22.6 per cent respectively over one, two and three years, while the benchmark returns were 19.4 per cent, 18.4 per cent and 21.2 per cent.

The biggest allocations in the Emerging Markets Bond Fund are in Russia (23 per cent of fund assets, about 7 per cent overweight the benchmark) and Mexico (about 20 per cent). In both cases, analysis and country visits convinced Mr Hasenstab these nations had their houses in order financially.

'We spend a lot of time looking at the politics. That was one of the drivers of our overweight Russia position. After the chaos of the Boris Yeltsin administration, President Vladimir Putin came in and established a fairly strong rule of law. He implemented reforms and had the political consensus to do it. So it is a combination of the leadership having the right approach and the political ability to do it. Russia was one of those good opportunities where both were the case.'

At mid-month, Russian bonds were showing a one-year return of about 33 per cent on the benchmark JP Morgan Emerging Bond sub index.

'Russia has been a core holding and I think it will remain one. They are generating fiscal surpluses consistently and using those surpluses to trade down debt and create reserves for the future, in case oil prices fall. The current account surplus remains quite strong at around 8 per cent. That is combined with capital inflows as Russian money comes back. Reserve growth in the past year was almost US$10 billion, which provides a liquidity cushion. And economic growth remains fairly strong, at around 4 per cent despite the global slowdown. It is being driven by domestic demand, it is not just export-led,' Mr Hasenstab said.

Venezuelan bonds make up about 5 per cent of the Emerging Market Bond Fund's portfolio. Franklin Templeton has bought more Venezuelan bonds during the political crisis, reasoning the attractive yields of 17-19 per cent outweighed any chance of default. 'The long-term solvency outlook is quite strong for Venezuela once they start pumping oil again. The administration there might move to a more populist agenda and become more prudent, or the government could be removed by election or referendum. There is short-term risk but we feel we are being compensated through the very high yields.'

Mexico, the Emerging Markets Fund's second-biggest holding, is a good example of a nation with a commitment to investor relations. 'They really made a concerted effort to communicate after the peso crisis in 1995. They have come a long way.'

Mexican sovereign debt is rated at investment grade, which means the market sees no default risk.

'It does not face liquidity risks, so although there is price risk, we can earn the high spread - 200-300 basis points over US Treasuries - with the comfort of knowing they have the solvency and liquidity fundamentals to weather global volatility.'

The mandate of the Emerging Markets Fund allows the managers to buy corporate and sovereign bonds, but they have confined their investment to governments. 'We have found governments offer more value and less liquidity risks than corporates. A lot of emerging market corporates have liquidity issues during falling markets. We are not likely to start buying them.'

In Asia, the fund holds sovereign bonds from Malaysia, South Korea and the Philippines. Asia is seen as offering low volatility with a healthy 250 basis point spread over US Treasuries. 'Obviously there is a lower absolute total return potential, but on a risk-adjusted basis, I think it is an important diversifier.

'Asia can also be a source of capital if there is a crisis event. If there is an event shock somewhere in this asset class we will be able to have the cash to take advantage of that and buy on the dips. We know we will always be able to sell Asian bonds.'

Asked about the performance of emerging markets bonds compared with equities in the year ahead, Mr Hasenstab said amid the volatility, managers liked to avoid making public predictions. However, he said the drivers of bond performance last year remained in place: credit improvement within countries, lower external debt levels and debt service costs, helped by rising exports, strong economic growth and better international reserves.

'Emerging market bonds have performed well during a period of fairly high global volatility. In a lot of ways it was a stress test for the asset class and it performed pretty well. The question for 2003 is: 'Are those conditions going to continue?' They seem to be on track. Emerging markets would also get a boost if the global economic environment improves and they start to benefit from capital flows.'



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